5 Things To Remember As You File Your Section 83(b) Election

As the founder of a startup company, by the time you get to the point of filing a Section 83(b) election with the IRS, you will have most likely already bought a helmet to keep your brains from flowing freely out of your ears from the mindboggling number of details involved in starting a company. You have been counseled on what type of entity to form, where to incorporate, founder vesting schedules, and myriad other details. You have gotten all of your documents executed and in place. You have properly completed and filled out your Section 83(b) election. Now all you have to do is file it. You are just about done! The purpose of this post is to give you guidance on this last step.

There are few tax code sections with rules as stringent as Section 83(b). Along with the rules being very specific and time sensitive, not complying with them could cause a founder to owe substantially more income tax down the road than necessary. So, put the helmet on and let’s go.

What is an IRS Section 83(b) Election?

Section 83(b) is a small, but very significant section of the federal tax code. Generally, under the U.S. tax law if you receive property in connection with the performance of services that is not transferable or is subject to a substantial risk of forfeiture, you don’t have to pay tax on the value of the property until it is transferable or not subject to a substantial risk of forfeiture. The Section 83(b) election is an election to include in income the value of property received in connection with the performance of services, despite the fact that the property is not transferable and subject to a substantial risk of forfeiture.

See why we warned you about your helmet? Whether you are a founder or an employee, if you receive an amount of stock in a company that may not be recognized as income until the stock vests, paying taxes on it could be a very different proposition between receipt and vesting. That is the purpose of the 83(b) election. If a founder or employee makes a voluntary Section 83(b) election, they recognize the stock as income upon the purchase of the stock rather than later, when the stock might be worth much more (and the tax would be much greater).

“Without such election, the forfeiture and transfer restrictions would postpone the time at which the service provider recognizes compensation income with respect to such property to when the restrictions lapse,” Michael Gentile (of DWT) advises. “Because a Section 83(b) election affects the timing (and thus potentially the character) of income recognized by a service provider with respect to property he or she receives in connection with the performance of services, there are a number of factors to consider in deciding whether to make such election.”

Section 83(b) Election: 5 Things To Remember

We have provided a sample 83(b) transmittal letter to the IRS for your convenience. Beyond the stringent rules and confusing verbiage behind the code, and making sure that you have completed the election form correctly, it is important that you don’t screw up the mechanics of making the election. Remember these things as you actually file the election.

Deadline – You have 30 days upon receipt of the stock to send your election letter. Don’t miss the deadline; there is no reprieve. It’s not personal, it’s an IRS thing.

Filing address – Remember, you file the election with the IRS; not with the company or the company’s attorney (you do provide the company a copy of your election, however). Make sure you file your election with the right office of the IRS – the internal revenue office where you file your tax returns. Check the filing address on the IRS web site to make sure you have it right. Remember also that you have to file a copy of your 83(b) election with your income tax return for the taxable year in which the property was transferred.

Certified mail – Send the letter by certified mail with a return receipt requested. Sure, it costs a little more, but every detail and countermeasure counts.

Spousal signature - If you are married and in a community property state, have your spouse sign too.

Disclosure - Provide a copy of the election letter to the company, not-only for their records, but for redundancy purposes also. Plus, it is required by the rules.

Receipt - In your certified letter to the IRS, you will receive a receipt from the delivery certificate, but also enclose a self-addressed, stamped envelope and ask for the IRS to stamp it received and return it to you. That way you are guaranteed an actual breathing human looked at it.

“83(b) Election, For My Protection”

Now say the above line five times fast. That should be enough to emphasize the importance of this issue to your personal income. Nobody wants to pay more taxes than they need to. Isn’t the fun part about paying taxes figuring out ways NOT to pay taxes? Okay, there’s nothing fun about taxes (except perhaps receiving refund checks), but there is a certain peace-of-mind in knowing that you have taken all of the proper steps and done everything you can to keep as much of that hard earned cash as you can. Or in your case, peace of mind. You can take your helmet off now.

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About Joe Wallin

Joe Wallin focuses on emerging, high growth, and startup companies. Joe frequently represents companies in angel and venture financings, mergers and acquisitions, and other significant business transactions. Joe also represents investors in U.S. businesses, and provides general counsel services for companies from startup to post-public.

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Sam

If a founder fails to make an 83(b) election within the 30 day period, can’t the restrictions on the stock (the vesting arrangements) be restructured as a repurchase agreement? That way full ownership would have occurred at the initial grant of stock, tax could be paid at the low initial valuation, and yet the benefits of vesting (for investors or co-founders) would be preserved. Thoughts?

joewallin

A fair market value repurchase right? This question is not amenable to a standard reply. I’d recommend you consult with a tax advisor.

http://www.facebook.com/profile.php?id=100004139313717 Sam Iam

Seems the following scenario must take place all the time; in it no 83(b) election is necessary because shares vest upfront, and restrictions are imposed at a later point. Scenario: Founders in a garage issue themselves a bunch of shares. Months later, they solicit an investor who insists that restrictions in the form of a repurchase option be imposed before any investment will be made (so the founders can’t keep their shares if they walk away the day after the investment is made). Nothing special about the Repurchase option, I think typically the price is at the lower of fair market or the purchase price paid by the Founders (basically nothing). If the scenario above is unremarkable, then the following should be as well. Scenario: Founder fails to timely to file an 83(b) election, so he tears up his Restricted Stock Purchase Agreement (or most likely he never entered into one as he just had a handshake deal with his co-founders and never got around to formally issuing stock when he should have) and enters into (i) a plain vanilla stock grant back-dated date X and (ii) a Restricted Stock Agreement dated date X+1 week. Now, tax is owed on any income represented by the stock grant just as if an 83(b) election had been made. Doesn’t seem like there’s any rocket science here. These documents aren’t filed, no one dictates what the dates must be, so long as it’s done before a tax filing has been made it would seem straightforward enough.

NoGioi

What authority requires giving a copy to the company? Can you let us know? Thanks!

Completely agree with this. In particular, BE SURE TO SEND via certified mail to the IRS. Our CPA, unbelievably, did not and now I’m trying to get confirmation that the IRS received it 5 months later. No one there has any idea what I’m talking about, which should come as no surprise I guess.

http://startuplawblog.com/joewallin Joe Wallin

Yeah, I also like the idea of sending a self addressed stamped envelope and asking the IRS to mail back the extra copy enclosed with the stamp received on it.

Great post, Joe. Can you touch on filing an 83(B) Election upon the exercise of an ISO for unvested shares? Thanks!

http://startuplawblog.com/joewallin Joe Wallin

The IRS’s position is that an 83(b) election for an early exercise ISO only works with respect to the AMT, not the regular income tax. This is a complex situation that you should consult a tax advisor about before exercising.

Denise

what’d happen if spouse did not sign the election?

http://startuplawblog.com/joewallin Joe Wallin

You mean you filed it timely without having signed it?

Denise

yes and they are in CA, so it is a community property state. this is for a 2012 election which was filed timely but without spouse’s signature. However; 2012 return is on extension. not filed yet.

I would argue no…especially if you don’t live in a community property state. But, why not just have the spouse sign, to relieve you of all worries?

Robin

If the options you are exercising are partially vested, do you file an 83(b) election for the entire amount, or just the unvested piece?

http://startuplawblog.com/joewallin Joe Wallin

You only have to file the election with respect to unvested shares.

Lynn

what if you live in CA, are married and file your taxes jointly, but your accounts and property are legally (thru a prenup) separate – does I need my spouses signature on the form as well?

http://startuplawblog.com/joewallin Joe Wallin

Why not just for safety’s sake?

Lynn

because I fear his signature would imply he is a part owner of these shares, which he is not … will this?

http://startuplawblog.com/joewallin Joe Wallin

Ok. Fair enough. But how is it different from signing joint returns? I would ask your tax return preparer or tax advisor. This is a blog. Happy to help more if you want to engage us. You can call me at 206 757 8184. This blog doesn’t constitute legal advice.

C-3P0

I’m a start up employee who is about to start a divorce process and have been filing taxes as ‘married, but filing separately’. However, I’m presented with a SECTION 83(b) ELECTION and it must be signed soon and there is a space for “Spouse” to sign. Must my spouse sign it as well as our we haven’t filed jointly for the past couple of years and we’ll be divorced in the next 5-6 months? Thanks!!

Also side note: We got married in Pennsylvania and I live in California and my spouse in Washington state.

abcluv

I filed a 83b three years ago, and the company has just sold. I don’t have a copy of this form now (trying to locate it!). Once it is filed, is there any copy I can get from somewhere? What do I need to do with this form now?

http://startuplawblog.com/joewallin Joe Wallin

Generally speaking, it is hard to collect these forms from the IRS if you didn’t keep a copy. Did you find it, by the way?

As far as reporting your tax consequences now, you would not need the form to report the sale correctly. It sounds like you should have a long term capital gain, but you should always consult a tax advisor as to your particular deal and its particular deal terms.

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Engineer

Would there be any case for the IRS to invalidate my 83(b) election if I included the entirety of my shares (vested and unvested up front at grant issue date)? In the section where I describe the restrictions of the stock, I specify that that the UNVESTED portion is forfeited upon termination. I have also declared the FMV and the amount I paid for the entire stock (vested and unvested).

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